Weekly comment: UBS acquires Credit Suisse as banking concerns grow

Market overview – Alan McIntosh, Chief Investment Strategist

Greater concerns surrounding the health of the global banking system have weighed on stock markets and sent investors piling into government bonds in recent trade. That said, the MSCI All Country World Index was broadly flat last week, leaving the benchmark with year-to-date gains of 2.2% and US benchmarks even managed to chalk up a weekly gain despite heavily negative news flows.

Reports over the weekend that UBS has agreed a US$3.25bn rescue deal for Credit Suisse is welcome in that it shows a failure has been averted, though the fact that one of the largest global investment banks required rescuing, and at a price well below Friday’s closing market value, speaks volumes about the financial health of Credit Suisse.

The acquisition will see UBS pay Sfr0.76 (Swiss francs) a share in its own stock, almost 60% less than the Sfr1.86 closing price from last week. The Swiss National Bank (SNB) has also offered its support, providing a Sfr100bn liquidity line and a loss guarantee of up to Sfr9bn – but only after the first Sfr5bn of losses has been taken by UBS.

This comes just over a week after the collapse of Silicon Valley Bank (SVB) and given the size and scale of Credit Suisse’s operations and exposure represents a different level of global concern and potential systemic impact than that for a regional US bank. The troubles faced by SVB were quite specific to the US and largely a result of their mismanagement of interest rate risk. Regulation will likely be heightened in the area as a result, but large US banks and European peers are unlikely to face additional regulatory requirements given the already significant measures in place.

Credit Suisse has faced a series of issues in recent years culminating in last week’s turmoil, with its handling of the Greensill Capital and Archegos crises resulting in billions of dollars of losses and causing lasting damage to its risk management reputation.

UBS shares traded sharply lower on Monday following the announcement of the acquisition despite the reduced purchase price of US$3.25bn (Sfr3.0bn), with Credit Suisse’s market capitalisation of US$8bn last Friday down around 75% in the last 12months. UBS’s market capitalisation last Friday was around US$57bn and it posted a 2022 profit of US$7.6bn whereas Credit Suisse reported a US$7.9bn loss last year, effectively wiping out a decade’s worth of gains.  

There was some confusion in bond markets on Sunday when the news of the acquisition broke, with Credit Suisse’s riskiest bonds, called additional tier one (AT1) rallying, quoted as high as 50 to 70 cents just hours before some US$17bn of bonds were declared worthless. The conditions of these bonds state that they would either get written down or converted to equity once a certain trigger is hit. It was believed by some bondholders that AT1 holdings would only face losses after equity capital is wiped out, following the traditional hierarchy whereby debt claims supersede those of equity. However, in this instance the writing down of Credit Suisse assets meant the bank fell below key thresholds of balance sheet metrics for tier one capital.

Instruments such as AT1 were designed following the 2007-08 banking crisis and after being written down to zero in this instance there is a feeling among some that they are not quite working as expected. This development has also led to strong selling of AT1 bonds at several other banks on Monday morning.

The situation regarding banks is clearly very fluid at present but we remain of the opinion that there is a lot of bad news already in the price and that, by and large, the banking system as a whole appears to be on a far firmer footing than the 2007-08 crisis.

Capital return is a key part of the positive case for banks at the moment and that is continuing. It seems highly unlikely that we will return to the situation during the pandemic when regulators prevented banks from conducting share buybacks and paying out dividends in Europe.

US outperformance

Despite the relatively small change overall for global equity markets last week there were some fairly large moves going on under the surface. The UK market was one of the worst hit, declining over 3% with its relatively large weighting to Oil majors and banks weighing on performance. Brent crude, the international oil benchmark, declined 12% last week, falling to its lowest level since December 2021 and ending around US$72/barrel. There are also growing signs of stress in credit market with spreads increasing as investors demand a higher level of compensation for taking on risk.

Although the recent troubles emanated in the US their stock markets have fared relatively better than peers with US large cap indices ending last week up 1.5%. Tech shares outperformed, benefitting from the falling yield environment. It seems that investors have become more concerned on the prospects of Europe in what is a role reversal of what had hitherto been one of the themes of 2023. This appears, at least in part, due to the macroeconomic backdrop being more challenging in many ways in Europe as they are further behind in their cycle of raising interest rates and are still battling with higher inflation.  

The European Central bank (ECB) had the unenviable task of being the first major central bank to hold a scheduled monetary policy decision in the wake of Silicon Valley Bank’s collapse. Despite the recent financial turmoil, the ECB went ahead with its planned 50 basis point increase last Thursday taking the benchmark deposit rate to 3.0%, although the accompanying communication suggested that futures increases will be dependent on more benign market conditions than we have witnessed in recent weeks.

After strong hints at the previous meeting that the bank would deliver another 50 basis point increase there was a concern that not doing so would raise credibility issues, but after recent developments it is unlikely we will see the same level of pre-commitment going forward and central bankers will likely seek to retain as much flexibility on policy as possible.

This week the Federal Reserve (Fed) and Bank of England (BoE) will announce the outcome of their latest policy decisions. Bond markets are pricing a 50:50 chance of a 25 basis point increase from the Fed and assigning a greater probability that the BoE may pause. The Fed funds rate is currently 4.75% and the BoE base rate 4.0%.

Government bond markets extended their recent rally last week, providing some diversification benefits amid equity market volatility. The US 10-year Treasury yield declined just under 30 basis points on the week, hitting its lowest level since February before closing at 3.43%. Gilt yields fell a little more with the 10-year gilt yield down 36 basis points to end at 3.28%.

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